Capital Gains Tax – an explanation

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Capital Gains Tax (CGT) is a tax which hits more and more people these days. I am going to set out a few of the key points to aid readers’ understanding.

CGT may never affect you, but it may be of some importance if you:

  • Own a holiday home here or abroad.
  • Sell shares worth thousands.
  • Have a rental property
  • Inherit a property
  • May sell a business (or part of one)
  • Buy or sell valuable antiques or paintings

Capital Gains Tax is, like it says on the tin, is a Tax on Capital Gains. It is different from Income Tax, which hits profits from business and earnings from jobs and savings.

In general for CGT to affect you in a specific year you need to have disposed of something. You might not have received any money for it (as in a gift to family). There can be a gain as a result of giving an asset, house or business to a family member, despite little or no money changing hands.

You must also have made a gain before CGT is payable. This means the disposal value must be more than the thing has cost you. In the case of a transfer to a connected party like a relative then the disposal value is taken to be the open market value. (Transfers between spouses are different again – no CGT applies).

The gains on all assets sold in the year are added up and any losses for that year deducted.

The following are deducted from your sales proceeds when working out your capital gain:

  • Costs of sale such as legal fees and estate agents
  • Costs of purchase including stamp duty and legal fees.
  • Capital improvements to the property (central heating, garage, conservatory etc)

If the overall net gain(s) exceed your annual exemption then CGT will be payable.

The annual CGT exemption for 2010/11 was £10,100 and it is £10,600 for 2011/12.

Once you exceed the gain then the CGT may be taxed at 18% and 28%. It is tacked onto the top of your income to decide what rates apply. If you pay 40% (or 50%) tax on your income then 28% will be the CGT rate on the gains. Some people will pay some tax at 18% and the rest at 28%.

If you pay 20% income tax then the gains will be taxed initially at 18% (not 20%), unless they are big enough to push you into the 40% income tax bracket. In that case the last part of the gains will be taxed at 28%.

CGT is a messy subject and one where there are a lot of misconceptions. You really are best advised to speak to an expert at an early stage. Once the deal is done you will have to pay the tax that is correctly due. On the other hand by taking advice early (ideally before you acquire the asset in the first place) then you maximise your opportunities for saving tax at the end.

Huston’s Hint

Transfers between spouses do not attract CGT. If only one spouse owns the asset then putting it into joint names well before selling it can save you CGT.